World Trade: An Overview

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1. Who trade with whom?

1. Size matters: The Gravity model
2. Using the Gravity model
3. Trade impediments: Distance, barriers, borders and
others

2. The Changing pattern of world trade

1. Has the world gotten smaller?
2. What do we trade
3. Service offsoring

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 1-Who Trades with Whom?

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 Fig. 2-1: Total U.S. Trade with Major
Partners, 2012
• More than 30% of world
output is sold across
national borders.
• The 5 largest trading
partners with the U.S. in
2012 were Canada, China,
Mexico, Japan, and
Germany.
• The largest 15 trading
partners with the
U.S. accounted for 69% of
the value of U.S. trade in
2012.

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 Size Matters: The Gravity Model

• 3 of the top 10 trading partners with the U.S.

in 2012 were also the 3 largest European
economies: Germany, the United Kingdom, and
France.
QUESTION:

• Why does the United States trade more with

these European countries (Germany, the
United Kingdom, and France) than with
other countries?

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 Fig. 2-2: The Size of European Economies,
and the Value of Their Trade with the United
States
ANSWERS
• These countries have
the largest gross
domestic product
(GDP), the value of
goods and services
produced in an
economy, in Europe.
• Each European
country’s share of U.S.
trade with Europe is
roughly equal to its
share of European GDP.
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 Size Matters: The Gravity Model (cont.)

• The size of an economy is directly related to

the volume of imports and exports.
– Larger economies produce more goods and
services, so they have more to sell in the export
market.
– Larger economies generate more income from
the goods and services sold, so they are able to
buy more imports.

• Trade between any two countries is larger,

the larger is either country.

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 Size Matters: The Gravity Model
(cont.)
• The gravity model assumes that size and distance
are important for trade in the following way:
Simplification:

Actual model:

where
Tij is the value of trade between country i and country j
A is a constant
Yi the GDP of country I, Yj is the GDP of country j
Dij is the distance between country i and country j
• Or more generally: Tij = A x Yia x Yjb /Dijc
where a, b, and c are allowed to differ from 1.

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 QUESTION

• Do you think that the Gravity

model is right for all cases? Is
there any outlier?

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 ANSWERS:

• A gravity model fits the data on with

European countries well but not perfectly.
• The Netherlands, Belgium and Ireland trade
much more with the United States than
predicted by a gravity model.
– Ireland has strong cultural affinity due to
common language and history of migration.
– The Netherlands and Belgium have transport cost
advantages due to their location.

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 QUESTION

Can you suggest other factors that can have

impacts on trade value btw 2 countries?

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 Impediments to Trade: Distance,
Barriers, and Borders
Other things besides size matter for trade:
1. Distance between markets influences transportation costs
and therefore the cost of imports and exports.
2. Cultural affinity: close cultural ties, such as a common
language, usually lead to strong economic ties.
3. Geography: ocean harbors and a lack of mountain barriers
make transportation and trade easier.
4. Multinational corporations: corporations spread across
different nations import and export many goods between
their divisions.
5. Borders: crossing borders involves formalities that take time,
often different currencies need to be exchanged, and
perhaps monetary costs like tariffs reduce trade.

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 Impediments to Trade: Distance,
Barriers, and Borders (cont.)
• Estimates of the effect of distance from the gravity
model predict that a 1% increase in the distance
between countries is associated with a decrease in
the volume of trade of 0.7% to 1%.
• Besides distance, borders increase the cost and
time needed to trade.

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 Fig. 2-3: Economic Size and Trade
with the United States

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 Impediments to Trade: Distance,
Barriers, and Borders (cont.)
• Trade agreements between countries are intended
to reduce the formalities and tariffs needed to cross
borders, and therefore to increase trade.
• The U.S. signed a free trade agreement with Mexico
and Canada in 1994, the North American Free
Trade Agreement (NAFTA).
• Because of NAFTA and because Mexico and Canada
are close to the U.S., the amount of trade between
the U.S. and its northern and southern neighbors
as a fraction of GDP is larger than between the U.S.
and European countries.
– Canada’s economy is roughly the same size as Spain’s (around
10% of EU GDP) but Canada trades as much with the United
States as does all of Europe.
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 Impediments to Trade: Distance,
Barriers, and Borders (cont.)
• Yet even with a free trade agreement between the
U.S. and Canada, which use a common language,
the border between these countries still seems to
be associated with a reduction in trade.
• Data shows that there is much more trade between
pairs of Canadian provinces than between Canadian
provinces and U.S. states, even when holding
distance constant.
• Estimates indicate that the U.S.-Canadian border
deters trade as much as if the countries were
1,500-2,500 miles apart.

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 Fig. 2-4: Canadian Provinces and U.S. States
that Trade with British Columbia

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 Table 2-1: Trade with British Columbia, as
Percent of GDP, 2009
British Columbia
British Columbia
(Canada)
(Canada)

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 2-The Changing Pattern of World Trade

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 Has the World Gotten Smaller?

• The negative effect of distance on trade according

to the gravity models is significant, but has grown
smaller over time due to modern transportation and
communication.
• Technologies that have increased trade:
– Wheels, sails, compasses, railroads, telegraph, steam
power, automobiles, telephones, airplanes, computers, fax
machines, Internet, fiber optics, personal digital assistants,
GPS satellites…

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 Has the World Gotten Smaller? (cont.)

• Political factors, such as wars, can change trade patterns

much more than innovations in transportation and
communication.
• World trade grew rapidly from 1870 to 1913.
– Then it suffered a sharp decline due to the two world wars and
the Great Depression.
– It started to recover around 1945 but did not recover fully until
around 1970.
• Since 1970, world trade as a fraction of world GDP has
achieved unprecedented heights.
– Vertical disintegration of production has contributed to the rise in
the value of world trade through extensive cross-shipping of
components.

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 Fig. 2-5: The Fall and Rise of World Trade

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 What Do We Trade?

QUESTIONS
What kinds of products do nations trade now?
How does this composition compare to trade in the
past?

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 What Do We Trade? (cont.)

ANSWERS
• In the past, a large fraction of the volume of trade came from
agricultural and mineral products.
– In 1910, Britain mainly imported agricultural and mineral
products, although manufactured products still represented most
of the volume of exports.
– In 1910, the U.S. mainly imported and exported agricultural
products and mineral products.
– In 2002, manufactured products made up most of the volume of
imports and exports for both countries.

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 Table 2-2: Manufactured Goods as a
Percent of Merchandise Trade

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 Fig. 2-6: The Composition of World
Trade, 2011
ANSWERS
Today, most (about 53%) of the
volume of trade is in manufactured
products such as automobiles,
computers, and clothing.
• Services such as shipping, insurance,
legal fees, and spending by tourists
account for about 20% of the volume
of trade.
• Mineral products (ex., petroleum,
coal, copper) remain an important
part of world trade at 19%
• Agricultural products are a relatively
small (8%) part of trade.

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 Low- and middle-income countries
have also changed the composition of
their trade.

• More than 90 percent of the exports of China, the

largest developing country and a rapidly growing
force in world trade, consist of manufactured
goods.

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 Fig. 2-7: The Changing Composition of
Developing-Country Exports
In 2001, about 65% of
exports from low- and
middle-income countries
were manufactured
products, and only 10%
of exports were
agricultural products.
In 1960, about 58% of
exports from low- and
middle-income countries
were agricultural products
and only 12% of exports
were manufactured
products.

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 Service Outsourcing

• Service outsourcing (or offshoring)

occurs when a firm that provides services
moves its operations to a foreign location.
– Service outsourcing can occur for services that
can be transmitted electronically.
• A firm may move its customer service centers whose
telephone calls can be transmitted electronically to a
foreign location.

– Other services may not lend themselves to being

performed remotely.

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 Fig. 2-8: Tradable Industries’ Share of
Employment Service outsourcing is
currently not a
significant part of
trade.
Some jobs are
“tradable” and
thus have the
potential to be
outsourced.
Most jobs (about
60%) need to be
done close to the
customer, making
them nontradable.

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 Summary

1. The 5 largest trading partners with the U.S. are

Canada, China, Mexico, Japan, and Germany.
2. The largest economies in the EU undertake the
largest fraction of the total trade between the EU
and the U.S.
3. The gravity model predicts that the volume of
trade is directly related to the GDP of each trading
partner and is inversely related to the distance
between them.

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 Summary (cont.)

4. Besides size and distance, culture, geography,

multinational corporations, and the existence of
borders influence trade.
5. Modern transportation and communication have
increased trade, but political factors have
influenced trade more in history.
6. Today, most trade is in manufactured goods,
while historically agricultural and mineral products
made up most of trade.

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